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When to Play
By Brett N. Steenbarger, Ph.D.
In a game of Texas Hold’em, each player receives
two cards initially. Then the betting begins. After that round,
the dealer uncovers a set of three cards. These cards, called the
flop, are available for use by all players to create the strongest
possible hand. Then another round of betting commences. Next, for
all who decide to stay in the game, a single card—the turn—is
uncovered. This, too, is available to all players. After yet
another round of betting, the final communal card—the river—is
turned over. At that point, there is a showdown and the strongest
hand takes the pot.
One of the cardinal skills of Texas Hold’em is
the decision of when to play and not play. Do you fold, do you
call, or do you raise? All you see initially are the two pocket
cards. You have no idea of the cards held by the other players or
the cards you might be able to use from the flop, turn, and river.
All you can do is try to assess your odds and the competition. The
player who has done his research knows that, in an eight hour poker
game where 35 games per hour are played, the number of times he will
be dealt an unsuited Ace, King will average between three and four.
Those are rare, good pocket cards and you have to play them.
Conversely, a low, nonconsecutive, unsuited hand gives little in the
way of odds and, in a game with ten other strong players, you would
be wise to fold and wait for something better.
Traders face the same question of when to play.
If they are trading frequently on an intraday basis, they want
volatility—even if there is no dominant trend. Good intraday swings
provide a number of opportunities to make money on the long and
short side. Conversely, low volatility days will meander in a tight
range for hours at a time. Even if your timing is good enough to
catch a swing within the tight range, the accumulated commissions
over the day can eat you up.
To address the issue of when to play, I looked at
the Spiders (SPY), which closely mimic the S&P emini futures. I
selected the period from September, 2002 to the present (8/27/04),
which included 493 trading days, and I calculated the correlation
between the day’s volume and the day’s range. Note that, in
calculating the range, I am examining the difference between the
highest and lowest points actually traded during the day—not the
day’s price change (which could be a function of overnight
trading). The day’s range is a particularly relevant measure of
volatility for the intraday trader. Interestingly, the correlation
was a highly significant .605. Stated in other terms, about 36% of
a day’s volatility is accounted for by the day’s volume.
That provides us with a potential edge. After
the market opens, you—the trader—are dealt two pocket cards. All
you see is what the market has done during the initial period of
trading. You have to decide whether you fold or bet. As the
trading game progresses, the next time periods provide you with the
flop. Once again, you decide that the day is offering you a great
hand—and you eventually go all in—or that you’ll bet more modestly
or not at all. Still later, in the afternoon, the market reveals
the turn and river and decide how, if at all, you’ll stay in the
game. By looking at the volume of the market hand you’ve drawn, you
can make some inferences about that market’s volatility. If the
overnight Globex session has shown unusually high volume and
volatility, I can look for a wider range in early morning trading.
If the morning trade—my pocket cards—shows little volume, I have
little reason to expect a wide-range trending movement in the midday
(when volume and volatility tend to be lowest in general).
Just as in poker, the market player updates
estimates of odds with each new “card” that is revealed. Is volume
and volatility, relative to recent historic averages, growing or
shrinking? Is it historically low, average, or high? Is there
enough movement here to make me want to play the game?
The professional poker player Ken Warren advises,
“The important thing to remember is that your goal is not to play
hands of poker, but to make the best decisions hand in and hand
out. You’re playing to win money, not to play cards, as paradoxical
as that sounds.” Similarly, your goal as a trader is to make money,
not to trade. If the market is not providing you with tradable
swings, do you want to be in the game? The really good poker
players—and traders—know not only how to play, but when not to play.
There is one important difference, however,
between poker and trading. In poker, you can draw a 7 2
and bluff the table, betting aggressively and making others think
that you’ve drawn the nuts. Other players might even capitulate and
cede the pot to you. In trading, unless you trade enough size to
move the market, there is no bluffing when the opening period
provides a narrow range on low volume. If you go all in, betting on
a breakout move, there is a good likelihood that you’ll be
revisiting the opposite side of the trading range before that
breakout ever occurs. Those are the situations that separate
traders who want to trade from those who need to
trade.
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Brett N. Steenbarger, Ph.D. is a clinical
psychologist and active trader, writer, and
researcher for the past 20 years, Brett is the
author of The Psychology of Trading (Wiley;
2003) and numerous articles on trading psychology
for print and online financial publications.
Click here for full
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